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The Farm CPA: Why You Might Want to Use a Disclaimer

17:13PM Apr 21, 2017

The amount you can be worth and not pay any federal estate taxes, a value known as the lifetime exclusion, is almost $5.5 million. Yet there are many farm couples who have land holdings far greater than these levels. Their children who farm actively might have a net worth approaching this level.

In that case, it might not make sense for producers to leave assets to their children. Otherwise, their children could be required to pay estate taxes shortly after the parents’ estate pays estate taxes. To avoid this type of scenario, it might make sense to use a disclaimer.

Disclaimers originate from the common law of gifts, which requires the donor to make the gift and the donee to receive it. If the donee declines the gift in a timely way, no gift is considered to have been made.

An Important Resource. This lets a person reject a lifetime or testamentary gift, causing the gift to automatically transfer to the next person in line. This disclaimed interest passes as though the disclaimant were not alive to receive the gift. If the disclaimer is qualified for estate-tax purposes, the disclaimant is treated as having never received the disclaimed gift for purposes of federal gift, estate and generation-skipping transfer taxes. 

Suppose Farmer Joan dies. The land she owned is valued at $25 million. Her two sons, who have three children each, receive the land equally. If they are not alive, the land will be transferred to the grandchildren. Farmer Joan’s sons are each worth over $10 million, and both are in poor health. Her estate has sufficient assets to pay the tax, and the land will transfer free of estate taxes. At the time of the sons’ death, the estates would each owe about $5 million of federal estate tax. If they properly disclaim their interest in the farmland, though, it will pass to their children, postponing additional estate tax for several decades.

To be effective for tax purposes, disclaimers must comply with both federal and state law. They must be in writing, identify the interest being disclaimed and be signed by disclaimants or their representatives. 

Usually, the disclaimer must be filed within nine months of the estate transfer, the disclaimant must not have previously accepted the disclaimed gift or any benefits from the gift, and the gift must pass automatically to the next person or persons in line.

If the person wishes to retain a certain portion of the gift, a partial disclaimer is usually allowed. For example, if there is a bequest of 320 acres of land, the disclaimant can disclaim 160 acres and retain the rest.

A common use of a disclaimer is to correct the transfer of assets at death. In many cases, a family situation might lead to a desire to more equitably allocate assets between the family or a charity. A disclaimer can accomplish this goal effectively, but the rules must be followed. Several years might have passed since the creation of the will, and the heirs might feel a disclaimer of certain assets by certain heirs could more readily accomplish the goal of a deceased parent.

Effective Strategies. In certain situations, an heir with large debts might want to use a disclaimer to automatically transfer the assets onto others. Proper counsel is warranted in this situation.

A disclaimer option might allow the surviving spouse greater flexibility to determine how much value should be given outright versus how much should be placed into a credit shelter trust, which allows assets to be placed into trust for the benefit of the surviving spouse. Upon the death of the surviving spouse, none of those assets are included in his or her estate. The savings from this type of trust can be substantial.

Most wills indicate some formula amount is automatically placed into the credit shelter trust. In many cases, there is little flexibility in determining the amount to be placed into the trust. The use of a disclaimer allows the surviving spouse to decide how many of the assets they wish to retain and how many they would like to go into trust. 

Consider discussing disclaimers with your estate- and succession-planning adviser. Proper up-front planning can save your family substantial sums.